May 01 Execution-control at Private Equity Portfolio Companies
A Blog by Carlos M Aquino & Stefan Anderson
Private equity (PE) value creation is often misunderstood as relying primarily on pulling financial engineering levers. Yet, we in the industry know this is a small part of the story. Current studies, reports and statistics relating to private equity point to a single fundamental value-creator: portfolio co-operational / financial outperformance. Defined in the context of private equity as a situation in which an investment generates a higher return than would be expected from the benchmark index of its respective market or industry, company outperformance was cited in a McKinsey report – surveying 11 leading PE firms worldwide – as having generated 63% of total value creation across a 60 deal sample size. 1 In this same survey, financial leverage and multiple accretion accounted for just 32% of value creation, reflecting the reality of a PE sector facing a period in which leverage and market factors contributing to returns are no longer the safe path for ensuring sustained success. 2
So how is that outperformance achieved? Fundamentally, enabling portfolio investments to outperform their market indices is a question of achieving management excellence. With the bulk of today’s private equity returns coming from operational improvements in portfolio companies, a PE firm’s success ultimately relies on an ability to consistently generate baseline operational improvements across each of its investments. Just like a multi-business company, a portfolio is the sum of its parts: if strategies and value creation initiatives for each underlying unit are not focused, robust, and well executed, the overall picture will at best fall short of its full potential.
There is a remarkable amount of consensus around the importance of successful strategy execution. Whether we choose to look at conclusions derived by relevant publications like the Harvard Business Review, industry leading consulting firms such as McKinsey or Deloitte, or business academics, there is a clear convergence around the view that the most successful private equity firms are simply applying more disciplined execution of value creation plans than their competition.3 Once set in motion, these plans are subject to constant review and adjustment in light of progress or issues identified by an appropriate set of key performance indicators designed to ensure the strategy remains on-track.4
This focus on operational efficiency exhibited by industry leaders reflects an understanding that skilful active management arguably represents the largest competitive edge PE firms possess. To this point, the private equity sector is far more deliberate than public companies in pushing their acquisitions through to the strategic implementation phase – generally in a matter of months as opposed to years – and in considering the furthest reaches of strategic planning.5
Simple as these observations may sound, executional excellence is in fact the number one challenge facing corporate leaders today 6. In the context of private equity, additional factors such as executive performance management, information asymmetry across the enterprise, and the often immature state of portfolio companies (especially formerly family-run) at acquisition serve to complicate matters even further. Looking ahead, the central role that operational efficiencies play in fuelling consistent returns paired with the innate difficulties of overseeing portfolio investments is requiring an industry that has long relied on manual data management processes to consider technology as an essential tool.
While the PE sector has been slow to embrace digitizing portfolio info, tools uniquely aligned with the needs of the industry are already readily available. Cloud computing’s provision of services such as software, big data / analytics, and collaborative networking over the internet represent a unique opportunity for private equity firms, allowing for greater and more thorough oversight of portfolio companies, and a significant reduction in information asymmetry. Further, targeted cloud software such as Corporate Strategy Management (CSM) platforms provide integrated solutions facilitating the key processes needed to achieve outperformance. Originally constructed as a tool for the C-Suite, CSM software expressly targets a private equity firm’s largest obstacle to achieving this goal: strategic and value creation plan implementation within and across its portfolio companies. If integrated across a portfolio, CSM cloud platforms can provide firms with the ability to see and track the status of all their investments in real time. Thanks to this increase in oversight-transparency provided by the cloud, timely and effective active management is greatly facilitated. The value of having the blueprints, measurements, and performance-trackers of each portfolio company’s plan available online, given the chronic risks of high management turnover is equally clear, providing an effective check to combat the challenges of retention and succession.
With real-world PE experience, consultants and academics are increasingly-aligned in the view that private equity value creation lies with a fund’s capacity to enable its portfolio companies to outperform their industry peers. Success in private equity today appears to be founded on ability to generate consistent value through high-quality management, clear strategic vision, and operational excellence. Looking ahead, the fact that PE must embrace cloud-based data management tools is a given. In an industry still in the early phases of digitisation, the cloud infrastructures available today through CSM platforms represent, for the moment, a unique competitive edge among PE funds.
About the Authors
Carlos M Aquino is founding Managing Director of CMA Pacific Partners, based in Hong Kong. He established the firm in 2002 and has served as a Senior Advisor to a wide range of PE firms in Asia-Pacific, most notably TPG, BPE, PAG, CVC, NSSK, and CITIC. He has also advised a wide variety of founder / family-led SMEs in the region, in addition to many PE portfolio companies in both industrial and consumer products and services sectors. Prior to his 15+ years in Asia PE, he spent the first half of his career as both an executive in industrial / tech companies including General Electric, 3COM, and McDonnell Douglas, as well as at management consultants Booz-Allen & Hamilton. Carlos received his undergraduate degree from the University of Michigan and a Masters of Public Affairs (International Relations) from Princeton University. Carlos is a member of the Board of Advisors to Chiefofstaff,com, the Corporate Strategy Management software platform designed for senior leaders of complex organizations. Learn more about Carlos on LinkedIn.
Stefan Anderson is currently a student at King’s College London and a project Manager at Enactus. Learn more about Stefan on LinkedIn.
About Chiefofstaff.com, LLC
Chiefofstaff.com is cloud-based enterprise Corporate Strategy Management (CSM) software that helps CEOs and the C-Suites of complex organizations manage and implement their strategic and operational plans. Chiefofstaff.com helps CEOs maintain a clear line of sight across all divisions and teams, ensuring plan implementation remains on schedule. The platform’s open communication fosters engagement within and across departments, teams and employees, so that everyone is on the same page. An integral part of the company’s culture is its commitment to the community. Through its support of the David Arthur Foundation, Chiefofstaff.com aims to strengthen and build innovative communities to solve autism life cycle needs and other social problems. To learn more, visit http://www.chiefofstaff.com.
- Joachim Heel and Conor Kehoe, Why Some Private Equity Firms Do Better than Others (McKinsey, 2005), accessed April 28, 2017, http://www.mckinsey.com/business-functions/strategy-and-corporate-finance/our-insights/why-some-private-equity-firms-do-better-than-others.
- See McKinsey, Deloitte, HBR reports cited below for services and business industry perspectives; Private Equity: Opportunities and Risks published by Oxford Scholarship for academic parallel.
- Matt Fitzpatrick, Karl Kellner, and Ron Williams, What Private-Equity Strategy Planners Can Teach Public Companies (McKinsey, 2016), accessed April 28, 2017, http://www.mckinsey.com/business-functions/strategy-and-corporate-finance/our-insights/what-private-equity-strategy-planners-can-teach-public-companies.
- Fitzpatrick, Kellner, and Williams, What Private-Equity
- Donald Sull, Rebecca Homkes, and Charles Sull, “Why Strategy Execution Unravels – and What to Do About It,” Harvard Business Review, March 2015, accessed April 28, 2017, https://hbr.org/2015/03/why-strategy-execution-unravelsand-what-to-do-about-it.
- Barber, Felix, and Michael Goold. “The Strategic Secret of Private Equity.” Harvard Business Review, September 2007. Accessed April 28, 2017. https://hbr.org/2007/09/the-strategic-secret-of-private-equity.
- Fitzpatrick, Matt, Karl Kellner, and Ron Williams. What Private-Equity Strategy Planners Can Teach Public Companies. McKinsey, 2016. Accessed April 28, 2017. http://www.mckinsey.com/business-functions/strategy-and-corporate-finance/our-insights/what-private-equity-strategy-planners-can-teach-public-companies.
- Heel, Joachim, and Conor Kehoe. Why Some Private Equity Firms Do Better than Others. McKinsey, 2005. Accessed April 28, 2017. http://www.mckinsey.com/business-functions/strategy-and-corporate-finance/our-insights/why-some-private-equity-firms-do-better-than-others.
- Lessons from Private Equity: How to Increase the Value of Private Companies in B.C. Vancouver: Deloitte, 2011.
- Link, Albert N., Christopher J. Ruhm, and Donald S. Siegel. Prviate Equity and the Innovation Strategies of Entrepreneurial Firms: Empircal Evidence from the Small Bussiness Innovation Research Programme. August 2012. Accessed April 28, 2017. http://www.nber.org/papers/w18297.pdf.
- Preece, Dianna C. “The Future of Private Equity.” In Private Equity: Opportunities and Risks, edited by Kent H. Baker, Greg Filbeck, and Halil Kiymaz. Oxford, UK: Oxford Scholarship, 2015.
- Sull, Donald, Rebecca Homkes, and Charles Sull. “Why Strategy Execution Unravels – and What to Do About It.” Harvard Business Review, March 2015. Accessed April 28, 2017. https://hbr.org/2015/03/why-strategy-execution-unravelsand-what-to-do-about-it.